Notes 11-20

Tax on items taken directly to equity is disclosed in note 30.

The Group earns its profits primarily in the UK, therefore the tax rate used for tax on profit on ordinary activities is the standard rate for UK corporation tax, which was 28.5% for 2008 (2007: 30%). Additional charges of 21.5% (2007: 20%) are applicable on the Group’s UK upstream profits. Taxation for other jurisdictions is calculated at the rates prevailing in those respective jurisdictions.

(b) Factors affecting the tax charge for the year

The differences between the total tax shown above and the amount calculated by applying the standard rate of UK corporation tax to the profit before tax is as follows:

(c) Factors that may affect future tax charges

The Group earns income from many activities, including oil and gas production in the UK, North America and elsewhere. On average, the Group pays taxes at higher rates than the current UK statutory rate of 28% (2007: 30%). The impact of higher rates, including petroleum revenue tax and the supplementary charge on UK Continental Shelf profits, is subject to the mix of the Group’s income. In the medium term, the Group’s effective tax rate is expected to remain above the UK statutory rate.

12. DIVIDENDS

The prior year final dividend was paid on 11 June 2008 (2007: 13 June). The interim dividend was paid on 12 November 2008 (2007: 14 November). The prior year final dividend of 9.65 pence (2007: 8.00 pence) per ordinary share and interim dividend of 3.90 pence (2007: 3.35 pence) per ordinary share have been adjusted to reflect the bonus element of the Rights Issue in the table above. Details of the Rights Issue are provided in notes 5, 29 and 30.

The Directors propose a final dividend of 8.73 pence per ordinary share (totalling £446 million) for the year ended 31 December 2008. The dividend will be submitted for formal approval at the Annual General Meeting to be held on 11 May 2009. These Financial Statements do not reflect this dividend payable, which will be accounted for in shareholders’ equity as an appropriation of retained earnings in the year ending 31 December 2009.

13. EARNINGS PER ORDINARY SHARE

Basic earnings per ordinary share has been calculated by dividing the loss attributable to equity holders of the Company for the year of £145 million (2007: earnings of £1,505 million) by the weighted average number of ordinary shares in issue during the year of 4,198 million (2007: 4,126 million). The weighted average number of ordinary shares outstanding and the dilutive impact for both periods presented has been adjusted to reflect the bonus element of the Rights Issue. Details of the Rights Issue are provided in notes 5, 29 and 30. The Directors believe that the presentation of adjusted basic earnings per ordinary share, being the basic earnings per ordinary share adjusted for certain re-measurements and exceptional items, assists with understanding the underlying performance of the Group. The reconciliation of basic to adjusted basic earnings per ordinary share is as follows:

Certain re-measurements (notes 2 and 8) included within operating profit comprise re-measurements arising on energy procurement activities and re-measurement of proprietary trades in relation to cross-border transportation or capacity contracts. Certain re-measurements included within discontinued operations in 2007 comprise re-measurement of the publicly traded units of The Consumers’ Waterheater Income Fund. All other re-measurements are included within results before exceptional items and certain re-measurements.

In addition to basic and adjusted basic earnings per ordinary share, information is presented for diluted and adjusted diluted earnings per ordinary share. Under this presentation, no adjustments are made to the reported earnings for either 2008 or 2007, however the weighted average number of shares used as the denominator is adjusted for potentially dilutive ordinary shares. In 2008, no outstanding awards or options are considered to be potentially dilutive for diluted earnings per ordinary share, because doing so would decrease the loss per ordinary share. However, potentially dilutive ordinary shares were taken into account when calculating adjusted diluted earnings per ordinary share.

15. OTHER INTANGIBLE ASSETS

(a) Carrying amount of goodwill and intangible assets with indefinite useful lives allocated to cash-generating units

Goodwill acquired through business combinations and indefinite lived intangible assets have been allocated for impairment testing purposes to individual cash-generating units each representing the lowest level within the Group at which the goodwill or indefinite lived intangible asset is monitored for internal management purposes as follows:

(b) Basis on which recoverable amount has been determined

Value in use calculations have been used to determine recoverable amounts for all of the goodwill and indefinite lived intangible asset balances noted above, with the exception of the impairment test for the Centrica Energy – Gas production and development cash-generating unit, where fair value less costs to sell has been used as the basis for determining recoverable amount.

(i) Value in use

The value in use calculations use cash flow projections based on the Group’s internal Board-approved three-year business plans. The Group’s business plans are based on past experience and adjusted to reflect market trends, economic conditions, key risks, the implementation of strategic objectives and changes in commodity prices, as appropriate. Commodity prices used in the planning process are based in part on observable market data and in part on internal estimates. The extent to which the commodity prices used in the business plans are based on observable market data is determined by the extent to which the market for the underlying commodity is judged to be active. Note 28 provides additional detail on the active period of each of the commodity markets in which the Group operates.

Cash flows beyond the three-year plan period have been extrapolated using growth rates in line with historic long-term growth rates in the market where the cash-generating unit operates.

Cash flows are discounted using a discount rate specific to each cash-generating unit to determine the cash-generating unit’s value in use, which is then deemed to be its recoverable amount. The recoverable amount is compared to the carrying value of each cash-generating unit’s net assets to determine whether the carrying values of any of the Group’s goodwill or indefinite lived intangible asset balances are greater than their corresponding recoverable amounts.

(ii) Fair value less costs to sell

Fair value less costs to sell is used as the basis for determining the recoverable amount of goodwill allocated to Centrica Energy – Gas production and development. This methodology is deemed to be more appropriate because it is based on the post-tax cash flows arising from each field within Centrica Energy – Gas production and development, which is consistent with the approach taken by management to evaluate the economic value of the underlying assets.

Fair value less costs to sell is determined by discounting the post-tax cash flows expected to be generated by the gas production and development assets within Centrica Energy – Gas production and development, net of associated selling costs, taking into account those assumptions that market participants would use in estimating fair value. Post-tax cash flows are derived from projected production profiles of each field within Centrica Energy – Gas production and development, taking into account forward prices for gas and liquids over the relevant period. Where forward market prices are not available, prices are determined based on internal model inputs. Note 28 provides additional detail on the active period of each of the commodity markets in which the Group operates.

The date of cessation of production depends on the interaction of a number of variables, such as the recoverable quantities of hydrocarbons, the production costs, the contractual duration of the licence area and the selling price of the gas and liquids produced. As each field has specific reservoir characteristics and economic circumstances, the post-tax cash flows for each field are computed using individual economic models and key assumptions as determined by management. Post-tax cash flows used in the fair value less costs to sell calculation for the first three years are based on the Group’s internal Board-approved three-year business plans and, thereafter, are forecast on a consistent basis. The future post-tax cash flows are discounted using a post-tax nominal discount rate of 8.5% to determine the fair value less costs to sell of Centrica Energy – Gas production and development. Fair value less costs to sell is compared to the carrying value of the Centrica Energy – Gas production and development cash-generating unit to determine whether goodwill is impaired. The discount rate used in the fair value less costs to sell calculation is determined in the same manner as the discount rates used in the value in use calculations described below, with the exception of the adjustment required to determine an equivalent pre-tax discount rate that is not required for the fair value less costs to sell calculation.

(c) Key rates used in value in use calculations

(i) Growth rate to perpetuity

Long-term growth rates are determined using a blend of publicly available historical data and long-term growth rate forecasts published by external analysts.

(ii) Discount rates

The Group uses surrogates in an attempt to estimate a market assessment of the time value of money and the risks inherent in the Group’s business plans in order to discount the forecast cash flows of each of the Group’s cash-generating units. Discount rates are derived from the Group’s weighted average cost of capital by replacing the Group’s beta with the betas of companies comparable to each of the Group’s cash-generating units to estimate a cash-generating unit specific weighted average cost of capital. Each cash-generating unit’s specific weighted average cost of capital is then adjusted to reflect the impact of tax in order to calculate an equivalent pre-tax discount rate.

Long-term growth rates used in the value in use calculations for each of the Group’s cash-generating units are provided in the table below together with pre-tax discount rates.

(iii) Inflation rates

Inflation rates used in the three-year business plan were based on a blend of a number of publicly available inflation forecasts available in the UK, Europe, Canada and the US. Inflation rates used for the value in use calculations were as follows: UK and Europe – 2.5% in 2009 and 2% in 2010 and 2011, Canada – 2.3% in 2009 and 2% in 2010 and 2011 and the US – 2.9% in 2009 and 2% in 2010 and 2011.

(d) Key assumptions used and summary of results

(i) British Gas Business

Key assumptions

• Gross margin percentage: based on contractual terms for customers on existing contracts and achieved gross margin percentages in the period leading up to approval of the business plan for new and renewal customers adjusted to reflect current market conditions and higher expected transportation costs.
• Revenues: based on the average market share achieved immediately prior to the approval of the business plan, adjusted for growth forecasts based on sales and marketing activity and recent customer acquisitions, with prices based on forward market curves for both gas and electricity.
• Operating costs: based on a projection of headcount in line with expected activity and salary increases based on inflation expectations, with a slight increase in the provision for credit losses experienced historically to reflect the current economic environment in the UK.

Summary of results

The recoverable amount of the British Gas Business cash-generating unit exceeded its carrying value at the impairment test date. Reasonably possible changes in the key assumptions listed above would not cause the recoverable amount of the goodwill to be equal to or less than the carrying amount.

(ii) British Gas Services – Dyno-Rod

Key assumptions

• Gross margin percentage: based on achieved gross margins in the period leading up to approval of the business plan.
• Revenues: based on revenue levels achieved in the period leading up to approval of the business plan adjusted for the impact of increased marketing spend and the targeting of key accounts with individual sales staff, with a slight reduction in growth rates to reflect the current economic environment in the UK.
• Operating costs: based on a projection of headcount in line with expected activity and salary increases based on inflation expectations.

Summary of results

The recoverable amount of the British Gas Services – Dyno-Rod cash-generating unit exceeded its carrying value at the impairment test date. Reasonably possible changes in the key assumptions listed above would not cause the recoverable amount of the goodwill or indefinite lived intangible asset to be equal to or less than their carrying amounts.

(iii) Centrica Energy – Gas production and development

Key assumptions

• Cash inflows: based on forward market prices for gas and oil for the active period of the market and internal model inputs thereafter, with reserve volumes and production profiles based on internal management estimates.
• Cash outflows: based on planned capital expenditure and the estimated future costs of abandonment.
• Taxation: based on tax rates expected to be in effect at the point of the forecast cash flow.

Summary of results

The recoverable amount of the Centrica Energy – Gas production and development cash-generating unit exceeded its carrying value at the impairment test date. Reasonably possible changes in the key assumptions listed above would not cause the recoverable amount of the goodwill to be equal to or less than the carrying amount.

(iv) Direct Energy – Mass markets energy

Key assumptions

• Gross margin percentage: based on contractual terms for customers on existing contracts and achieved gross margin percentages in the period leading up to approval of the business plan for new and renewal customers, adjusted to reflect competitor data, where available. Where applicable, regulated gross margin percentages are based on the gross margin percentages included in regulatory applications submitted to the Alberta Utilities Commission in Canada.
• Revenues: based on average market share by individual market sector achieved in the period immediately prior to the approval of the business plan, adjusted for expectations of growth or decline based on individual jurisdiction to reflect regulatory or competitive differences, including customer propensity to switch, and contractual prices, with non-contractual prices based on forward market gas and power curves in Canada and the US.
• Operating costs: based on a projection of headcount in line with expected activity and salary increases based on inflation expectations, with a slight increase in the provision for credit losses experienced historically to reflect the current negative economic environment in the US, and, to a lesser extent, Canada.

Summary of results

The recoverable amount of the Direct Energy – Mass markets energy cash-generating unit exceeded its carrying value at the impairment test date. Reasonably possible changes in the key assumptions listed above would not cause the recoverable amount of the goodwill to be equal to or less than the carrying amount.

(v) Direct Energy – Commercial and industrial energy

Key assumptions

• Gross margin percentage: based on achieved gross margin percentages in the period leading up to approval of the business plan, increased to reflect an expected easing of competitive pressure throughout the plan period and decreased to reflect the current negative economic environment in the US, and, to a lesser extent, Canada.
• Revenues: based on historical growth trends and planned sales activities by individual market sector with an adjustment to reflect an increase in volumes driven by the acquisition of Strategic Energy as explained in note 35. Prices are based on forward market curves for gas and electricity in Canada and the US.
• Operating costs: based on expected increases in existing cost base to reflect increased activity as a slightly declining percentage of gross margins to reflect expected synergies associated with the acquisition of Strategic Energy as explained in note 35.

Summary of results

The recoverable amount of the Direct Energy – Commercial and industrial energy cash-generating unit exceeded its carrying value at the impairment test date. Reasonably possible changes in the key assumptions listed above would not cause the recoverable amount of the goodwill to be equal to or less than the carrying amount.

(vi) Direct Energy – Home and business services

Key assumptions

• Gross margin percentage: based on gross margin percentages achieved in the period leading up to approval of the business plan, adjusted to reflect the current economic conditions and housing decline in North America.
• Revenues: based on historical growth trends by individual market sector adjusted for new product offerings and continued penetration into new markets.
• Operating costs: based on projected headcount and inflationary increases.

Summary of results

The recoverable amount of the Direct Energy – Home and business services cash-generating unit exceeded its carrying value at the impairment test date. Reasonably possible changes in the key assumptions listed above would not cause the recoverable amount of the goodwill to be equal to or less than the carrying amount.

(vii) European Energy – Oxxio

Key assumptions

• Gross margin percentage: based on the gross margin percentages achieved in the period leading up to approval of the business plan, adjusted to reflect the increase in levels of competition currently being experienced in The Netherlands.
• Revenues: based on customer account growth achieved in the period leading up to approval of the business plan, adjusted downward to reflect the impact of the recent increases in competition, with prices reflecting forward market curves for gas and electricity.
• Operating costs: based on projected headcount and inflationary increases adjusted to reflect recently implemented cost improvement programmes and an increase in web enabled customer solutions.

Summary of results

The recoverable amount of the European Energy – Oxxio cash-generating unit was below its carrying value by £45 million at the impairment test date and accordingly an impairment loss of this amount has been recognised in the Income Statement for the year ended 31 December 2008 within exceptional operating costs. The impairment loss arose due to a mixture of more competitive markets and lower margins in the forecast period due to procurement issues that arose during 2008 with the increased volatility in energy markets. The European Energy – Oxxio value in use calculation was based on a discount rate of 10.9% (2007: 10.7%), and assumed an average gross margin percentage of 9.0% over the three years with closing customer numbers of approximately 750,000 in all three years. At 31 December 2008, the carrying value of the European Energy – Oxxio cash-generating unit was equal to its recoverable amount. As a result, a reasonably possible decrease in gross margin percentage or customer numbers, below the levels used in the value in use calculation above, would potentially result in the recoverable amount of the European Energy – Oxxio cash-generating unit falling below its carrying value, triggering a further impairment loss. If, for example, the value in use calculation assumed gross margin percentages 0.5ppts lower, than those used, a further goodwill impairment loss of approximately £32 million would have been recorded, while a 5% reduction in customer numbers would have resulted in an additional goodwill impairment loss of approximately £23 million.

17. PROPERTY, PLANT AND EQUIPMENT

The net book value of assets to which title was restricted (Spalding finance lease asset) at 31 December 2008 was £351 million (2007: £379 million).

18. INTERESTS IN JOINT VENTURES AND ASSOCIATES

(b) Share of joint ventures’ assets and liabilities

The Group’s share of joint ventures’ gross assets and gross liabilities at 31 December 2008 principally comprises its interests in Braes of Doune Wind Farm (Scotland) Limited (renewable power generation), Barrow Offshore Wind Limited (renewable power generation) and Segebel SA (energy supply).

The Group’s share of the investments in and results of Braes of Doune Wind Farm (Scotland) Limited and Barrow Offshore Wind Limited are included within the Power generation segment. The Group’s share of the investment in and results of Segebel SA are included within the European Energy segment.

19. INVENTORIES

There are no inventories which are carried at fair value less cost to sell (2007: £nil). The Group consumed £515 million of inventories (2007: £488 million) during the year. Write-downs of inventory of £23 million (2007: £nil) were recognised in gross profit during the year to reflect the impact of a reduction in the forward market price of gas on the net realisable value of gas in storage and transportation, with £10 million recognised in Direct Energy, £8 million recognised in Centrica Energy and £5 million recognised in Centrica Storage.

20. TRADE AND OTHER RECEIVABLES

Trade and other receivables include financial assets representing the contractual right to receive cash or other financial assets from residential customers, business customers and treasury, trading and energy procurement counterparties as follows:

Receivables from residential and business customers are generally considered to be fully performing until such time as the payment that is due remains outstanding past the contractual due date. Contractual due dates range from being due upon receipt to due in 30 days. An ageing of the carrying value of trade and other receivables that are past due but not considered to be individually impaired by class is as follows:

At 31 December 2008 there were £107 million (2007: £87 million) of receivables, net of provisions for credit losses, from residential customers and £25 million (2007: £nil) from treasury, trading and energy procurement counterparties that were considered to be individually impaired. There were no individually impaired receivables, net of provisions for credit losses, from business customers. Receivables from residential customers are generally reviewed for impairment on an individual basis once a customer discontinues their relationship with the Group. The provision for credit losses is based on an incurred loss model and is determined by application of expected default and loss factors, determined by historical loss experience and current sampling to the various balances receivable from residential and business customers on a portfolio basis, in addition to provisions taken against individual accounts. Balances are written off when recoverability is assessed as being remote. Movements in the provision for credit losses by class are as follows:

The charge for the impairment of trade receivables is stated net of credits for the release of specific provisions made in previous years, relating mainly to residential customers in the UK, which are no longer required. At 31 December 2008 the Group held £23 million (2007: £36 million) of customer deposits for the purposes of mitigating the credit risk associated with receivables from residential and business customers. Exposure to credit risk associated with receivables from treasury, trading and energy procurement counterparties is monitored by counterparty credit rating as follows:

The unrated counterparty receivables are comprised primarily of amounts due from subsidiaries of rated entities, exchanges or clearing houses. Receivables from treasury, trading and energy procurement counterparties are managed in accordance with the Group’s counterparty credit policy as described in note 4.